[co-author: Stefan Okhuysen]

Q&A with Procopio Partner Paul Johnson and HCAP Partners Partner Stefan Okhuysen

What do private equity and growth capital investors look for when adding new companies to their portfolio, and what strategies do they apply to help those companies optimize capital? Procopio Partner and Mergers & Acquisitions and Strategic Joint Ventures co-leader Paul Johnson dove into that topic in a Q&A with Stefan Okhuysen, Partner of HCAP Partners. They covered the current private equity landscape, strategies for creating value, industry trends, various investment structures, and more.

Paul Johnson (PJ): Thanks for agreeing to this exchange with me, Stefan. Let’s look at the current landscape of private equity/growth capital investments. Where do you see it right now, particularly in light of recent economic conditions and market volatility?

Stefan Okhuysen (SO): My pleasure, Paul. As to the market, it’s been slow this first half of 2024 for buyout or majority recap transactions. There’s a lot of uncertainty in the market, mainly driven by the Fed’s unclear position on interest rates going forward, in addition to a lot of geopolitical noise and a very important election coming. The consensus of what we’ve heard from colleagues, along with what we are seeing, is that this year is even slower than last year. With that being said, we have seen a relatively stable flow of transaction on the healthcare front, one of our main sectors of interest.

On the other hand, we’ve seen a good amount of volume on the junior debt side. The delta between senior loans and junior loans has shrunk, and companies who require capital for growth or financing events see value in having more flexibility in the structure of a loan for a marginally higher price. We expect to continue to see this trend as banks seem to be being more conservative in their lending activities.

PJ: What strategies does a private equity firm use to create value within portfolio companies? Are there specific operational improvements or efficiencies you prioritize?

SO: The strategy varies on a case-per-case basis, as all companies are different and have different needs. Nevertheless, some of the key things we do are to surround the existing management team with key experts and additional resources, financial and technical, to help them professionalize, grow and institutionalize their companies. We’ve a built an incredible roster of operating partners, most of them who have been CEOs, CFOs, CMOs, etc., at successful companies that have been through similar growth processes, and work with them to create and implement value-creation roadmaps that will help the company accomplish its goals and go to the next level. These can include organic growth initiatives, technology implementation plans, financial discipline and reporting improvements, operational efficiencies, among others.

PJ: Given the current economic climate, what’s a wise course of action for pursuing working capital optimization within portfolio companies? What metrics should be tracked to ensure efficient capital management?

SO: Again, this varies on a company-by-company basis, as not all companies are the same and their cash cycles can be very different. With that being said, we pay close attention to collection and payable cycles, industry or macro events that may affect these, like supply chain disruptions, interest rates, industry-specific issues, etc. We work closely with companies to make sure they are adequately capitalized, and we emphasize being conservative on leverage ratios. We closely monitor, and assist our companies in monitoring, key debt indicators to make sure the companies are financially healthy and continue on a path to success.

PJ: Have you observed any consolidation trends within specific industries or sectors? How would a private equity firm position itself to take advantage of consolidation opportunities?

SO: We continue to see a pretty big trend to consolidate diverse services within the home and facility maintenance space, especially in HVAC services. Although we do look at this type of companies, we are mindful that valuation multiples have increased substantially due to this consolidation. For this reason, we try to look at other sectors that haven’t received as much attention and where there is still room to create meaningful platforms, while staying within reasonable valuations.

PJ: What does a typical investment structure look like for one of your investments? Percent of debt vs. equity? Warrants?

SO: We are a bit different from a lot of firms in the sense that we can move across the capital structure and tailor a transaction that provides a solution to each specific situation. Most of our transactions have a combination of debt and equity capital, or equitylike instruments like warrants. We can take minority or majority ownership positions.

PJ: Can you describe the typical portfolio company you’re looking for by industry and size, and any other factors, such as management team experience or stage of growth?

SO: Our overall parameters are $3 million to $15 million in EBITDA, growing and established companies, and experienced management teams. Our key sectors of interest are healthcare, business services, SaaS and niche manufacturing.

PJ: You mentioned healthcare. What types of businesses in that sector do you consider currently worth exploring? How do you assess risk and return in this space?

SO: One of the reasons that we like the sector is that it is not as susceptible to economic fluctuations, and that’s been a factor in us developing a lot of expertise in the healthcare industry over the past two decades. Nevertheless, it’s not a sector to invest in without significant expertise due to its complexity and heavy regulatory burden. We consider all of these factors when underwriting a transaction and we include them in return expectations.

We are actively exploring patient-facing healthcare services, especially those that are tech-enabled and have an established model that can be expanded and grown. We are also interested in services that help reduce costs and improve patient outcomes, which is a big trend in the industry.

PJ: This has been very informative, Stefan. For my final question, I’m wondering what advice you would give to company leaders when in discussions with interested growth capital partners?

SO: Thanks for the invitation, and that’s a great question to end on. I would say that interviewing and doing diligence on the firm you will partner with is important. All firms are very different and provide different solutions, which can include different levels of involvement in the operations and value creation, as well as different types of capital solutions and structures. Generally, most firms are open to prospective portfolio companies talking to existing and past portfolio company executives for reference checks.